There is an old joke that the only things that are inevitable are death and taxes. We hate taxes every time we pay them because of how much of our income it takes. And many homeowners hate mortgage penalties for the same reason, given how much they can cost, but unlike taxes, they are not inevitable. Let’s learn more about what mortgage penalties are and how to avoid them.
Mortgage Penalties Are Not Inevitable
First, know that mortgage penalties are not inevitable. We know this due to the sheer numbers that break mortgages, even if just refinancing their mortgage early. One study found that more than sixty percent of mortgages are refinanced by year three, though the most common mortgage in Canada is a five year mortgage.
If you have a variable rate mortgage, there is a good chance you won’t have an IRD penalty if you refinance into a fixed rate mortgage. Refinance your mortgage in Fort McMurray before interest rates rise as expected in 2018.
You may be able to break the mortgage without a penalty in the case of an approved bona fide sale. However, this depends on the terms of your current mortgage.
Mortgage Penalties Vary Between Lenders
Each mortgage lender has its own penalty for calculating mortgage penalties. For example, not all lenders use the discount you received. This lowers the IRD and thus your penalty. Another area where they differ is the term they use for calculating the IRD. Some lenders round the remaining months on the mortgage to the next longest term while others round down. If you have 22 months left on your mortgage, many lenders would round up to a 24 month term while others would run the calculation at 22 months. You should contact your current mortgage lender to ask for an accurate quote of the prepayment penalty instead of assuming what you’ll pay to break your mortgage.
The Size of Mortgage Penalties
Breaking a fixed rate mortgage typically brings a penalty. The penalty will generally be either three months interest or the interest rate differential (IRD). The IRD is based the difference between interest rates the lender can lend at today versus the interest rate of the original mortgage.
The Interest Act does not allow for an IRD penalty on terms over five years after five years have passed. In these cases, the maximum IRD is a three month interest penalty. If you have been in a six year mortgage for five years, you’d pay the maximum interest penalty of three months.
If interest rates are falling, your IRD prepayment charge will go up. If interest rates are going up, your IRD prepayment charge will go down. However, the interest rate is only one factor in this equation.
As you get closer to the maturity date of your mortgage, the IRD prepayment charge will decrease assuming interest rates remain the same. If interest rates go up and you’re getting closer to the maturity date, your mortgage penalty will fall. If interest rates are falling, the IRD will go up even as you get closer to the end of your mortgage.
The Bank of Canada says it is considering slowly raising interest rates as necessary in the future. This will cause IRD payments to go down, though it is in your benefit to contact a Fort McMurray mortgage broker today to lock in a lower interest rate before they go up. You’ll save more on the mortgage payments over the life of the loan than you’d pay in the prepayment penalty.
Mortgage Penalties Don’t Just Hit Those Refinancing
If you pay down your mortgage, you’ll eliminate your house payment that much faster. However, mortgage lenders lose out on interest if you shorten the loan term. This is why most mortgage loans limit what you’re allowed to prepay, a term ironically called “pre-payment privileges”. This means many lenders may charge you a penalty if you dramatically pay down your mortgage. In this case, the IRD is based on the amount you’re pre-paying.
If you’re considering buying a new home, contact a Fort McMurray mortgage broker to find a lender who won’t charge you for the “privilege” of paying down the home loan faster.